Traditionally (and when they could afford to), parents have provided cash to their offspring for down payments on homes. But in these days of tightened credit guidelines, some parents take bigger steps to help their kids become homeowners at today's low interest rates.
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Three factors determine whether it's financially smart for parents to help adult children buy homes: the parents' finances, the kids' finances and the real estate deal itself.
"The first rule of thumb is that parents should never get financially involved with their adult offspring unless they are adequately prepared to address their own needs and pending retirement, which may not be far down the road," says Guy Penn, principal and founder of G.M. Penn Wealth Management in O'Fallon, Mo.
Penn says while there's no one-size-fits-all answer to whether parents should help their offspring buy a home, it definitely is a bad idea to pull money from a retirement account to give assistance.
Jeffrey Ivory, a partner with Stonebridge Financial Partners in Bingham Farms, Mich., says, "If parents are giving their kids down payment money, they should be willing to lose that money and not get it back. If they are helping their kids by buying a home and renting it to them or by co-signing their loan, they need to have not only the liquidity for the down payment, but they also need to be certain they can pick up the mortgage payments if the kids cannot pay them."
Adult Offspring Finances
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Parents should make sure they are helping their kids for the right reasons, Ivory says.
"If the kids can't get a loan on their own, the parents really need to know why not," says Ivory. "If the scenario is that your kids are going through a divorce or a job loss and you want to help them, tying them to a permanent location may not help. If they are dealing with the financial consequences of credit problems, helping them pay off their credit card debt may be more important than buying a home. But if you are helping a young couple with stable jobs who just haven't had time to save for a down payment, and you can easily afford to help, this could make sense."
Ivory says parents should ask their kids to pull their credit scores and show it to them, and ask to see their paychecks and credit card debt.
"If your kids are already struggling, then you are setting them up to struggle more if you get them into a house they can't afford," Ivory says.
Educating Your Kids
Ivory says parents should talk to their kids about the rules of thumb of homeownership, including keeping all total debt including housing costs to less than 38% of monthly income before taxes. Housing costs, including taxes, homeowners insurance, homeowners association dues, and principal and interest on the mortgage, should be less than 28% of gross monthly income.
"The No. 1 way a parent can help their children is to offer them the gift of knowledge," Penn says. "Parents rarely have serious money discussions with their children, and throwing money in their direction now may be doing more harm than good. Parents should be talking to their kids realistically about the hidden costs of homeownership like utility payments, maintenance and repairs."
The Real Estate Deal
The simplest way parents can help their kids financially is with down-payment money.
"Lenders want to know if the money is a gift because if the parents are treating it as a loan, it will be considered a second loan on the home," says Dan Kruse, broker and president of Century 21 Affiliated in Madison, Wis.
Individuals can give $13,000 tax-free to another individual each year, Ivory says, so if two parents each give their offspring and their offspring's spouse the maximum, they can give a total of $52,000 tax-free.
Kruse says parents often buy a home as an investment and have their kids pay rent.
"The parents can then sell the home to the kids when they are ready, keep it as an investment property or sell it to someone else," Kruse says. "You can do this with two separate transactions, or you can make a rent-to-own arrangement with the parents giving the kids a rent credit toward the purchase."
Ivory says a lease-to-own arrangement requires consultation with a tax professional as well as a lender, and must include a written contract.
Even within the family, financial planners say it is crucial to have everything in writing to make sure there are no misunderstandings in the future about repayment plans or the consequences of a loan default.
Parents with enough cash can lend the entire mortgage to their offspring, but this too should be in writing and include a reasonable interest payment. "Everyone needs to pay attention to the law and to the tax consequences of any financial arrangement," says Ivory.
Most financial planners view co-signing a loan as the worst option because of potential damage to the parents' credit and cash flow if the kids cannot make the payments.